I Agree with Scott Sumner

On most monetary issues, I don't. But I like this post, where he comes out four square in favor of using the monetary base as his measure of the money supply.

So when people start asking me about the banking system and reserves and loans my eyes just glaze over. Most of the base is normally cash, and monetary policy consists of changing the supply of cash relative to demand. The nominal size of the entire banking system and all its components; capital, loans, reserves, deposits, etc., is determined endogenously, just like the nominal size of the plastic surgery industry, or nominal size of the ice cream industry. Normally, a permanent 20% increase in the base would be expected to increase the nominal size of the banking, plastic surgery, and ice cream industries by 20%. But other things are often not equal.

Now, we can argue about whether there is a way to manipulate expected future paths of the monetary base to affect nominal GDP in the near term. In other words, we can argue about whether monetary policy can work with a lead rather than with a lag. We can argue about the extent to which the current recession can be "cured" by raising nominal GDP. But I agree with using the monetary base as the key indicator, and I agree with his reasoning for doing so. Read the whole thing.

Comments and Sharing

Arnold, I don't have time to explain the research done in the 1960s and early 1970s about money and monetary policy. And I don't know a good reference that summarizes the debates based on that research. But let me say that by 1975, I had learnt that the debate about M? --that is, the relevant definition of money-- was a waste of time. Forget about money and monetary policy; they make sense only during periods of hyper-inflation, that is, when governments attempt to finance an increasing amount of expenditures by printing currency.

The alternative is to focus on (1) the central bank and what it can do, and (2) the different types of financial intermediaries and their access to the central bank. A convenient starting point is their balance sheets (not as actually presented but as they should be presented if all transactions are properly recorded). For a central bank, the relevant disaggregation on the liability side is usually between currency and bank reserves (monetary base is equal to the sum of these two liabilities). Even in the old, pre-1980 banking system, the distinction was relevant, and certainly it became much more relevant since 1980. More important, in the asset side you have to distinguish between "active" and "passive" assets, the quantity of the first one under the direct control of the central bank and the quantity of the second determined by transactions (as in the case of international reserves in a fixed-exchange rate system). That's the minimum framework you need to understand central bank policy, but during a crisis you have to acknowledge the central bank's power to undertake other transactions and you should be careful not to include them in those four types of assets and liabilites (look at the records of Chile's central bank intervention in the 1982-83 crisis). The appropriate aggregation of assets and liabilities is critical to understanding central bank policies and as long as the categories of money and monetary policy are used it will be hard to do it. Read Charles Goodhart's FT article to which Tyler linked yesterday and my comment in Tyler's post.

If it was a good measure of the money supply shouldn't we be seeing MASSIVE inflation right now, I mean outside of precious metals and stocks? I mean it did double in 2008 over the course of a few months

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